Last Updated: January 2024
A “real estate professional” is more than just a fancy title. The real estate professional tax status is an official designation recognized by the U.S. Internal Revenue Service (IRS) for taxpayers who spend significant time in real estate businesses. This status can provide significant tax benefits, allowing the offset of non-passive income with rental losses that would otherwise be considered passive and limited in deduction. In order to qualify for this designation, a series of requirements must be met. Knowledge of this designation and its implications can greatly influence one’s tax strategy and rental real estate investment returns.
What is a Real Estate Professional?
A real estate professional is an individual who meets specific criteria outlined by the United States Internal Revenue Services (IRS) to be classified as such for tax purposes. To be considered a real estate professional, the individual must materially participate in rental property activities, meaning they are actively involved in the management and operations of properties on a regular, continuous, and substantial basis. By meeting these qualifications, real estate professionals may potentially offset rental property losses against their other income, providing valuable rental property tax benefits.
Real Estate Professional Tax Status Qualifications
Much like a 1031 exchange or cost segregation study, the process to qualify as a real estate professional requires the fulfilling specific qualifications. Below is a list of primary qualifications as set forth by the IRS:
- More Than 50% Rule: The individual must spend more than half of their professional time in real property trades or businesses in which they materially participate. This means that if you have another job outside of your real estate activities, you need to ensure you’re spending more time on your real estate activities to qualify.
- 750 Hour Requirement: The taxpayer must perform more than 750 hours of services during the tax year in real property trades or businesses in which they materially participate. These hours can include time spent on making rental real estate investments, managing properties, overseeing repairs, and so on.
- Single Taxpayer Requirement: Only one person in a spousal unit needs to meet the above qualifications. If one spouse qualifies as a real estate professional, the IRS treats the joint tax return as if both spouses are professionals, which can be advantageous when trying to meet the criteria.
- Material Participation: To show material participation in real estate activities, the taxpayer must meet one of seven tests outlined by the IRS, including spending over 500 hours in the activity during the year, performing virtually all participation in the activity, or participating over 100 hours and as much as any other individual.
Benefits to Being a Real Estate Professional
Being classified as a real estate professional for tax purposes can unlock significant tax benefits for individuals involved in rental property activities. Below is a list of a few of the primary benefits of being a real estate professional:
Rental Loss Deductions
Real estate professionals can deduct rental property losses against their other sources of income, such as wages, business income, or capital gains, potentially reducing their overall tax liability. This can be exceptionally helpful when assessing the tax ramifications of selling a rental property.
Taxable Income Reduction
The ability to deduct rental losses against other income can significantly reduce a real estate professional’s taxable income, potentially resulting in lower overall tax payments. This can be especially helpful if you have other income sources like a W2 job or own a business.
Self-Employed Business Deductions
As a real estate professional, you may be considered self-employed, which allows you to take advantage of deductions for business expenses that normally wouldn’t be permitted such as travel, home office expenses, marketing and advertising, and insurance.
Passive Activity Loss Limitation
Non-real estate professionals are subject to passive activity loss rules, which restrict the deductibility of rental property losses. However, real estate professionals are not subject to these limitations and can fully utilize rental losses to offset their income.
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Real Estate Professional Tax Status FAQ
How to Prove and Document Real Estate Professional Tax Status?
Proving and documenting real estate professional tax status requires careful record-keeping and thorough documentation. To establish material participation in rental property activities, individuals should maintain records (including dates) of their time spent on property management tasks performed. It’s advisable to keep a log or diary to track activities and maintain supporting documentation, such as emails, contracts, invoices, and receipts. Additionally, individuals should be prepared to provide evidence of their qualifications and involvement in real estate-related trade or business activities.
How Many Properties Do You Need to Qualify for Real Estate Professional Status?
The number of properties needed to qualify for real estate professional status for rental property taxes is not specifically defined by the IRS. Instead, the focus is on meeting the requirements of material participation in rental property activities, which involves actively and substantially participating in the management and operations of a rental property. It is possible to qualify as a real estate professional with a single property if the individual can demonstrate the necessary level of involvement and meet the other criteria set by the IRS.
Pro Tip
The key factor is the extent of active participation, rather than the specific number of properties owned.
Do Passive Investments Qualify for Real Estate Professional Status?
Passive investments typically do not qualify for real estate professional status for rental property taxes. To be classified as a real estate professional, individuals must materially participate in the management and operations of the rental properties. Passive investments, where the investor has limited involvement in the day-to-day activities, do not meet the criteria for material participation. Examples of passive real estate investments include note investing, real estate syndicate investing, real estate stock investing, and tax liens.
About the Author
Ryan Nelson
I’m an investor, real estate developer, and property manager with hands-on experience in all types of real estate from single family homes up to hundreds of thousands of square feet of commercial real estate. RentalRealEstate is my mission to create the ultimate real estate investor platform for expert resources, reviews and tools. Learn more about my story.
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